The Dynamic Effect of Devaluation on the Balance of Payments of a Small Debt-Ridden Open Economy.

This paper derives a precise necessary and sufficient condition for devaluation to eventually improve the balance of payments in domestic currency using assumptions more appropriate for a small open economy than those of Marshall-Lerner. It will be shown that, following devaluation, the balance of payments deteriorates over a short period before it gradually improves--the so-called J-curve effect. The duration of this short period will be shown to depend on the magnitude of trade elasticities, lag-coeffcients, unhedged foreign debt denominated in foreign currency, interest rate, and current account deficit. Copyright 1993 by The Economic Society of Australia.